FX Correlations (July): How Do Currencies Move In Relation To Each Other?

The following is our monthly correlations update for July. As we have mentioned time after time, correlations between different currency pairs will inevitably shift over time, therefore it is of utmost importance to keep abreast of these changes. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation versus the EURUSD as further confirmation of the correlation.
In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other. There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure. That is, having a portfolio that consists of the NZDUSD and USDCAD is different than having a portfolio comprised of NZDUSD and AUDUSD. As indicated in the tables below, over the past month, NZDUSD has had a relatively strong negative correlation (-0.64) with USDCAD and a considerable positive correlation to AUDUSD (+0.86). Therefore having long NZDUSD and long USDCAD exposure would generally negate profit or loss because when NZDUSD rallies, USDCAD will sell off the majority of the time. Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. On the other hand, holding long NZDUSD and long AUDUSD positions would be similar to nearly doubling up in one of the pairs since the correlation is so strong. Furthermore, we can tell from our tables that correlations shift with time. For example, USDCAD held an almost irrelavant negative correlation to NZDUSD (-0.33) over the past year. However, just this past month, the relationship has grown far more interesting (-0.64). Shifts such as these can be partially explained by changes in the severity of monetary policy or changes in unique domestic conditions. Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios.
Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

FX Correlations (data as of 08/01/07)